Navigate Singapore 2019 ~ Banks - OVERWEIGHT

Positive Trends

Further NIM upside on repricings and pass-through.

All 3 banks have benefited from the rate hikes, with three-month SIBOR/SOR averaging at 1.63%/1.62% in 3Q18 (2Q18: 1.51%/1.54%).

OCBC (SGX:O39) led the pack with a 5bp q-o-q NIM increase to 1.72% as it repriced its Singapore mortgages and released some US$3bn in excess liquidity. Note that its NIM stayed flattish at 1.67% over the past 3 quarters.

DBS (SGX:D05) has been the only local bank to deliver consistent q-o-q NIM growth over the past 4 quarters; its NIM widened 1bp to 1.86% in 3Q18. Management guides that there is a considerable lag – about 4-6 weeks (off previous month’s SIBOR) – between Fed hikes and the repricing of its SIBOR/SOR loans.

UOB (SGX:U11)’s NIM contracted further by 2bp q-o-q to 1.81% as the bank built up its liquidity buffers while loan drawdowns were delayed.

On balance, the banks have also started funding ahead, mainly in S$ FDs, in anticipation of still-increasing funding costs. We continue to project NIM upside as the full impact of mortgage repricing and rate pass-through as well as delayed drawdowns come into effect.

Steady asset quality amid the benign credit environment.

NPA formation was broadly stable with a slight uptick seen in UOB and OCBC, albeit not too much of a concern. NPL ratios stayed firm in 3Q18 (DBS: 1.6%, OCBC: 1.4%, UOB: 1.6%).

On balance, the slight uptick in UOB’s NPAs was more than offset by the NPL sale of a consumer portfolio in Thailand.

OCBC made a move to classify several weakened exposures related to palm oil and manufacturing as impaired and monthly flows of mortgage NPLs also contributed to its NPA formation. Other sources of credit weaknesses were scattered in terms of industry.

DBS recorded some pick-up in NPL across South and Southeast Asia but NPL was primarily attributed to the deterioration in an exposure in Indonesia that was caught up in a global restructuring exercise despite still generating cashflows.

The banks continue to keep a close eye on their portfolios in Greater China and asset quality of their exposures in this region remains contained. Material credit quality deterioration of this portfolio is not expected in the near term.

Negative Trends

Muted loan growth due to escalating trade tensions.

Singapore banks saw a more muted 3Q18 in terms of loan growth, with UOB recording +2.2% q-o-q and +9.4% y-o-y, OCBC +1.7% q-o-q and +10.9% y-o-y and DBS +0.7% q-o-q and +8.4% y-o-y. That said, the banks remain on track to mid-to-high single-digit loan growth for UOB and OCBC and 6-7% for DBS.

In 9M18 annualised terms, UOB’s loan growth was driven primarily by Greater China and Thailand. In particular, UOB noted a slowdown in credit growth to the manufacturing industry as corporates pushed back capex commitments. Greater China, Singapore and Malaysia stood as OCBC’s key growth drivers in 9M18 while South and Southeast Asia and Hong Kong were DBS’s.

Notably, the common theme amongst the 3 banks this quarter was the slower credit growth recorded in Greater China. OCBC cautions for loan growth from this region to slow as a whole in the coming year as a result of escalating trade tensions. DBS’s slower loan growth in 3Q18 was also attributable to the bank de-emphasising the expansion of its trade loan portfolio due to unattractive pricing. DBS had also observed a larger dip in new housing loan bookings than initially anticipated as a result of the property cooling measures, a trend we expect to see across its peers in the coming year.

Normalising credit costs.

Coming off a period of relatively muted credit costs following the accelerated recognition of weaker oil and gas exposures in FY17, impairment charges of all 3 banks started normalising towards their through-the-cycle average in 3Q18.

OCBC ’s allowances more than doubled q-o-q to S$49m or 8bp of loans (2Q18: S$21m, 3bp); the bank guides that credit costs should clock in at around 12-15bp under normal operating conditions in FY18-19.

The increase in DBS’s credit costs was more than we expected this quarter at S$236m or 21bp of loans (2Q18: S$314m or 12bp); this comes against its through-the-cycle average of 26- 29bp. A stabilisation in oil price may spur a pick-up in oil and gas-related recoveries but this prospect is guided to only be realised from 2H19 onwards.

On wealth management, OCBC has expanded its team of relationship managers and projects incremental returns y-o-y alongside continued growth in AUM while DBS eyes significant potential in recurring income from estate planning.

Trading income growth was mainly driven by larger customer flows. Despite the resilient non-interest income in 3Q18, we think that non-interest income may soften in 4Q18 as market sentiment remains weak.

Looking to 2019

Further upside in NIMs on the back of FY18’s flow-throughs and 3 potential hikes in FY19.

The potential 2 rate hikes in 1H19 and 1 in 2H19 feed into our forecasts of a NIM expansion across Singapore banks by 6- 9bp y-o-y in FY19. Broadly sustained US$ strength should see the increase in 3M LIBOR passing through into SIBOR/SOR/HIBOR in the coming quarters.

In tandem with positioning their product offerings to reap more fee-based income, the banks have also started taking preemptive measures to lock in requisite funding (before costs start rising) for projected loan drawdowns.

Credit costs likely to normalise to through-the-cycle average.

The accelerated recognition of oil and gas weaknesses in view of IFRS9 implementation late last year paved the way for muted credit costs in FY18. The banks have so far reported record low levels of impairment provisions and we think that this likely to normalise towards their respective through-the-cycle averages in FY19. The banks have so far reported record low levels of impairment provisions and have not observed material credit quality deterioration in any of their portfolios.

We will be keeping an eye on unsecured retail loans and SME exposures for difficulties in fulfilling repayments as interest rates rise although we note that any asset quality deterioration is likely to be moderate given the MAS’s limits on unsecured credit and that most of the latter is rather well-collaterised.

Corporate credit weaknesses have also been one-off. The still-benign credit environment should see impairment charges trending upwards but not to the extent of substantial earnings erosion.

Negative loan growth a key risk.

Singapore banks have cautioned for slower loan growth in 2H18 and for this trend to continue into FY19. While Greater China has been a main growth driver for the banks in FY18, loan growth slowed substantially q-o-q across all 3 banks in 3Q18 from c.+4-13% in 2Q18 to c.-2-+2% in 3Q18.

We take the signal from DBS that trade loan volumes in the coming year may remain muted due to unattractive pricing. The impact of unresolved trade tensions is also likely to weigh on regional growth as corporates contemplate moving production bases to overcome heightened tariffs, although this could be a longer-term prospect. We are cognisant that loan growth from the world’s production hub may well turn negative in the year to come.

The banks have also seen more pronounced effects on mortgage volumes than initially expected from the property cooling measures introduced in July 2018. The potential rate hikes may well be the saviour for banks’ bottomlines in the coming period of slower regional growth.

Stock preference

We remain Overweight on the sector. In order of preference, our picks are OCBC , UOB and DBS.

OCBC is our preferred bank as we expect the full repricing impact of its mortgage portfolio in Singapore to take effect in the coming quarter. We maintain a HOLD on DBS given its unattractive valuation of 1.3x FY18F P/BV; an attractive entry point would be about 1.2x P/BV.

Sector risks include weaker regional and domestic loan growth as well as subdued pass-through of Fed rate hikes into SIBOR/SOR.

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